Having an existing home equity or 2nd trust line can cause a problem when refinancing your mortgage. Unless you are closing the equity line/2nd trust and paying it off by wrapping it into the new loan amount, keeping your equity line/2nd trust could cause a problem in several ways. To keep your equity line/2nd trust when refinancing you have to get what is called a “subordination agreement.”
What is a subordination agreement?
A subordination agreement is something that shows the equity line/2nd trust lender will ‘subordinate’, or stay in 2nd trust position, when the 1st trust refinance takes place.
When a 1st trust is paid off, the 2nd trust automatically goes into 1st trust position. Of course the new lender who is paying off the existing 1st trust will mandate that they retain 1st trust position. Hence, the need for the ‘subordination agreement’ which shows the 2nd trust lender will stay in 2nd trust position.
What’s the problem?
It is all boilerplate paperwork, and is not a problem in theory. But in practice the real problem is timing, because banks are so backlogged and they have no real economic incentive to execute quickly and efficiently. Most lenders who hold an equity line will charge a small fee, $100 for example, to process a subordination agreement, which barely covers their overhead to process the paperwork required to do the subordination agreement.
Subordination agreement process.
And a subordination agreement is not simply preparation of one document. When an equity line/2nd trust lender agrees to subordinate, they underwrite an entire file, look at the appraisal, the 1st trust lenders approval, and all the credit characteristics that they would look at as if they were making the loan for the first time. As a result, there is quite a bit of work that goes into subordinating an existing equity line/2nd trust, so the process is not only expensive but it is cumbersome. Hence, it takes a while.
When you factor in that on top of that there is no way that an existing equity line/2nd trust lender can pile on a bunch of fees or points to give them economic incentive to perform quickly, they usually end up performing slowly.
I know that people cherish their equity lines/2nd trusts to have access to emergency money, as well as for home renovation projects. But many times they can cause problems in the refinance process. If an equity line has a zero balance, sometimes it is easier to close it out and not have it hinder the refinance process, and go back at a later date and apply for another one.
There is also the simple fact that with declining housing values of the past several years in many markets, people do not have the equity that they used to have in their homes when they first got the equity line/2nd trust, and as a result that equity line may cause a loan-to-value that is too high for a bank to approve a refinance.
It is good to ask a lender that you are refinancing with a lot of questions related to these topics if you have an equity line or 2nd trust. You may be going down a path that could be painful, and end up causing problems with you getting your refinance.